Economic Value Added (EVA) | Formula | Calculation | Top Examples

By Dheeraj Vaidya Leave a Comment

<img class="alignnone size-full wp-image-13072" src="https://cdn.wallstreetmojo.com/wp-

content/uploads/2016/12/economic-value-added_resize.jpg" alt="Economic Value Added (EVA)"
width="900" height="500" srcset="https://cdn.wallstreetmojo.com/wp-
content/uploads/2016/12/economic-value-added_resize.jpg 900w,
https://www.wallstreetmojo.com/wp-content/uploads/2016/12/economic-value-added_resize-
300x167.jpg 300w, https://www.wallstreetmojo.com/wp-content/uploads/2016/12/economic-value-
added_resize-768x427.jpg 768w, https://www.wallstreetmojo.com/wp-
content/uploads/2016/12/economic-value-added_resize-180x100.jpg 180w" sizes="(max-width: 900px)
100vw, 900px" />

Economic value added is a measure of surplus value created on a given investment. When a person is
investing his funds, he does this only because he expects to earn a profit from the investment. Let us
say, gold seems to be a good instrument to invest with a high profit margin.

 Total investment (i.e. price at which gold is purchased) = $ 1000

 Brokerage paid to the dealer for purchase of gold = $ 15

In a year, I would like to sell off the gold on account of liquidity crunch.

 Selling price of gold = $ 1200

 Brokerage paid to the dealer on sale of gold = $ 10

In the above Economic Value Added example,

 Economic Value Added = Selling price – Expenses associated with selling the asset – Purchase
price – Expenses associated with buying the asset

 Economic Value Added = $ 1200 – $ 10 – $ 1000 – $ 15 = $ 175

If we just see the profit, then the profit on selling gold was $ 1200 – $ 1000 i.e. $ 200. But the actual
creation of wealth is only $ 175 on account of expenses incurred. This is a very crude example of
Economic Value Added (EVA).

In this article, we discuss Economic Value added in detail –

 Economic Value Added (EVA) concept

 Economic Value Added Formula

 Economic Value Added Example (Basic)

 #1 – Calculate Net Operating Profit After Tax (NOPAT)

 #2 – Calculate Invested Capital

 #3 – Calculate WACC

 #4 – Economic Value Added (EVA) Calculation

 Important Accounting adjustments for Economic Value Added Calculation

 Colgate: Economic Value Added Example

 #1 – Calculating Colgate’s NOPAT

 #2 – Colgate’s Invested Capital

 #3 – Find WACC of Colgate

 #4 – Colgate’s Economic Value Added (EVA) Calculation

 What is the importance of Economic Value Added (EVA)?

 Advantages and disadvantages of using Economic Value Added (EVA)

Economic Value Added (EVA) concept

Economic value added (EVA) is the economic profit by the company in a given period. It measures the
company’s financial performance based on the residual wealth calculated by deducting its cost of capital
from its operating profit, adjusted for taxes on a cash basis.
It helps to capture the true economic profit of a company like we calculated the Economic Value Added
of investing gold in the above . Economic Value Added example was developed and trademarked by
Stern Stewart and Co. as an internal financial performance measure.

Economic Value Added Formula

The three main components of Economic Value Added (EVA) are:

1. Net Operating Profit After Tax

2. Capital Invested

3. WACC i.e. the Weighted Average Cost of Capital

Economic Value Added can be calculated with the help of the following formula:

Economic Value Added EVA formula= Net Operating Profit After Tax – (Capital Invested x WACC)

Here, Capital Invested x WACC stands for the cost of capital. This cost is deducted from the Net
Operating Profit After Tax to arrive at the economic profit or the residual wealth created by the
organization.

Economic Value Added Example (Basic)

#1 – EVA Formula – Net Operating Profit After Tax (NOPAT)

This represents how much will be the company’s potential cash earnings without its capital cost. It is
important to deduct tax from the Operating Profit to arrive at the true operating inflow that a company
will earn.

NOPAT = Operating Income x (1 – Tax Rate).

EVA Example for calculating Net Operating Income After Tax is as follows:

ABC Company

Abstract of the Revenue Statement

Year
Particulars
2016 2015

Revenue:

Project Advisory Fees $ 2,00,000 $ 1,86,000

Total Revenue (A) $ 2,00,000 $ 1,86,000

Expenses:

Direct Expenses $ 1,00,000 $ 95,000

Total Operating Expenses (B) $ 1,00,000 $ 95,000

Operating Income (C = A minus B) $ 1,00,000 $ 91,000

Tax Rate 30% 30%

Tax on operating income (D = C * Tax Rate) $ 30,000 $ 27,300

Net Operating Income After Tax (C minus D) $ 70,000 $ 63,700

#2 – EVA Formula – Capital Invested

This represents the total capital invested through equity or debt in a given company.

Continuing with the above EVA example of ABC Company, let us say the company has a total invested
capital of $ 30,000. Of this $ 20,000 is through equity funding and the rest ($ 10,000) is by means of long
term debt.

Also, have a look at Return on Invested Capital Ratio

#3 – EVA Formula – WACC

Weighted Average Cost of Capital is the cost the company incurs for sourcing its funds. The importance
of deducting the cost of capital from the Net Operating Profit is to deduct the opportunity cost of the
capital invested. Formula to calculate the same is as follows:

WACC = RD (1- Tc )*( D / V )+ RE *( E / V )

The formula looks complicated scary but if understood, it is fairly simple. It is much more easier if the
formula is put in words as follows:

Weighted Average Cost of Capital = (Cost of Debt) * (1 – Tax Rate) * (Proportion of debt) + (Cost of
Equity) * (Proportion of equity)

This makes the formula easier to understand and also self-explanatory.

Now, understanding the notations of the formula:

  RD = Cost of Debt

 Tc = Tax Rate

 D = Capital invested in the organization through Debt

 V = Total Value of the firm simply calculated as Debt + Equity

 RE = Cost of Equity

 E = Capital invested in the organization through Equity

An important point to note about this formula is that that Cost of Debt is multiplied by (1 – Tax Rate) as
there is tax saving on interest paid on debt. On the other hand, there is no tax saving on the cost of
equity and hence the tax rate is not taken into account.

Let us now look at how WACC is calculated.

ABC Company

Balance Sheet of the Company

Year
Particulars
2016 2015

Equity $ 20,000 $ 17,000

Debt $ 10,000 $ 7,000

Sources of Funds (A) $ 30,000 $ 24,000

Fixed Assets $ 20,000 $ 18,000

Current Assets $ 20,000 $ 16,000

Less: Current Liabilities $ 10,000 $ 10,000

Uses of Funds (B) $ 30,000 $ 24,000

Cost of Debt 8% 8%

Cost of Equity 10% 12%

WACC for the year 2016

 = 8% * (1- 30%) * ($ 10,000 / $ 30,000) + 10% * ($ 20,000 / $ 30,000)

 = (8% * 70% * 1/3) + (10% * 2/3) = 1.867% + 6.667% = = 8.53%

WACC for the year 2015

 = 8% * (1- 30%) * ($ 7,000 / $ 24,000) + 12% * ($ 17,000 / $ 24,000)

 = (8% * 70% * 7/24) + (10% * 17/24) = 1.63% + 8.50% = 10.13%

#4 – Economic Value Added EVA Calculation

From the above, we have all three factors ready for Economic Value Added calculation for the year 2016
and 2015.

Economic Value Added (EVA) for the year 2016 = Net Operating Profit After Tax – (Capital Invested *
WACC)

 = $ 70,000 – ($ 30,000 * 8.53%)

 = $ 70,000 – $ 2,559 = = $ 67,441

Economic Value Added (EVA) for the year 2015 = Net Operating Profit After Tax – (Capital Invested *
WACC)

 = $ 63,700 – ($ 24,000 * 10.13%)

 = $ 63,700 – $ 2,432 = = $ 61,268

Accounting adjustments for Economic Value Added Calculation

Now since we have understood the basics of EVA calculation, let us go a bit further to understand what
can be some of the real-life accounting adjustments involved especially at the Operating Profit level:

Sr. Changes to Net Changes to

Adjustment Explanation
No. Operating Profit Capital Employed

There are certain expenses which can

Long-term be classified as long-term expenses Add to Net Add to Capital
1
expenses such as research and development, Operating Profit Employed.
branding of a new product, re-branding
 of old products. These expenses may Also, check out
be incurred in a given period of time Return on Capital
but generally have an effect over and Employed
above a given year.

These expenses should be capitalized

while EVA calculation as they generate
wealth over a period of time and not
just reduce profit in a given year.

Let us categorize depreciation as

accounting depreciation and economic
depreciation for purpose of Difference in the
understanding. value of
Add accounting
accounting
Accounting depreciation is one which is depreciation depreciation and
2 Depreciation calculated as per Accounting policies economic
and procedures. Whereas economic depreciation
depreciation is one which takes into Reduce economic
should be
account the true wear and tear of the depreciation adjusted from the
assets and should be calculated as per capital employed
the usage of assets rather than a fixed
useful life.

These are expenses which do not affect

the cash flow of a given period.

EVA Example: Foreign exchange Add to capital

contracts are reported at fair value as Add to Net employed by
3 Non-cash expenses on the reporting date. Any loss incurred
Operating Profit adding it to
is charged to the Income Statement. Retained Earnings
This loss does not lead to any cash
outflow and should be added back to
the Net Operating Profit.

Similar to non-cash expenses, there are Subtract from

non-cash incomes which do not affect Subtract from capital employed
4 Non-cash incomes the cash flow of a given period. These Net Operating by subtracting it
should be subtracted from the Net Profit from Retained
Operating Profit. Earnings

To arrive at accounting profits, Add to Net Add to capital

5 Provisions
numerous provisions are created such Operating Profit employed
 as deferred tax provisions, provision for
doubtful debts, provision for expenses,
allowance for obsolete inventory, etc.
These are provisional figures and do
not actually affect the economic profit.
In fact, these provisions are generally
reversed on the first day of the next
reporting period.

Tax should also be calculated on actual

Tax is supposed to be deducted
cash outflow rather than the
after calculating Net Operating
6 Taxes mercantile system where all accruals
Profit. So it directly deducted and
are taken into account and only then
no other adjustments are required.
tax is deducted.

Colgate Economic Value Added Example EVA

#1 – Calculating Colgate’s NOPAT

Let us have a look at the Income Statement of Colgate.

<img class="alignnone size-full wp-image-25676" src="https://cdn.wallstreetmojo.com/wp-

content/uploads/2017/09/Colgate-EVA-NOPAT.jpg" alt="Colgate EVA NOPAT" width="860"
height="331" srcset="https://cdn.wallstreetmojo.com/wp-content/uploads/2017/09/Colgate-EVA-
NOPAT.jpg 860w, https://www.wallstreetmojo.com/wp-content/uploads/2017/09/Colgate-EVA-NOPAT-
300x115.jpg 300w, https://www.wallstreetmojo.com/wp-content/uploads/2017/09/Colgate-EVA-
NOPAT-768x296.jpg 768w" sizes="(max-width: 860px) 100vw, 860px" />
source: Colgate SEC Filings

 Operating Profit of Colgate in 2016 is $3,837 million

The operating profit above does contain noncash items like Depreciation and Amortization,
Restructuring costs etc.

In our EVA example, we assume that the book depreciation and economic depreciation are same for
Colgate and hence, no adjustment is needed when we calculated NOPAT.

However, restructuring cost needs to be adjusted for. Below is the snapshot of Colgate’s restructuring
costs from its 10K filings.

<img class="alignnone size-full wp-image-25677" src="https://cdn.wallstreetmojo.com/wp-

content/uploads/2017/09/Colgate-EVA-NOPAT-Step-2.jpg" alt="Colgate EVA NOPAT Step 2"
width="854" height="167" srcset="https://cdn.wallstreetmojo.com/wp-
content/uploads/2017/09/Colgate-EVA-NOPAT-Step-2.jpg 854w, https://www.wallstreetmojo.com/wp-
content/uploads/2017/09/Colgate-EVA-NOPAT-Step-2-300x59.jpg 300w,
https://www.wallstreetmojo.com/wp-content/uploads/2017/09/Colgate-EVA-NOPAT-Step-2-
768x150.jpg 768w" sizes="(max-width: 854px) 100vw, 854px" />

 Colgate’s restructuring charges in 2016 = $228 million

Adjusted Operating Profit = Operating Profit + Restrucutring Expenses

 Adjusted Operating Profit (2016) = $3,837 million + $228 million = $4,065 million

For calculating NOPAT we required the tax rates.

We can calculate the effecitve tax rates from income statement as per below.
<img class="alignnone size-full wp-image-25687" src="https://cdn.wallstreetmojo.com/wp-
content/uploads/2017/09/Colgate-WACC-Calculation-Step-5.png" alt="Colgate WACC Calculation - Step
5" width="866" height="249" srcset="https://cdn.wallstreetmojo.com/wp-
content/uploads/2017/09/Colgate-WACC-Calculation-Step-5.png 866w,
https://www.wallstreetmojo.com/wp-content/uploads/2017/09/Colgate-WACC-Calculation-Step-5-
300x86.png 300w, https://www.wallstreetmojo.com/wp-content/uploads/2017/09/Colgate-WACC-
Calculation-Step-5-768x221.png 768w" sizes="(max-width: 866px) 100vw, 866px" />

source: Colgate SEC Filings

Effective Tax rate = Provision for Income Taxes / Income Before income taxes

 Effective tax rate (2016) = $1,152/$3,738 = 30.82%

NOPAT = Adjusted Operating Profit x (1-tax rate)

 NOPAT (2016) = $4,065 million x (1-0.3082) = $2,812 million

Also, check out article on Non recurring items

#2 – Colgate’s Invested Capital

Let us now calculate the second item required for calculating Economic Value Added i.e. Invested
Capital.
<img class="alignnone size-full wp-image-25680" src="https://cdn.wallstreetmojo.com/wp-
content/uploads/2017/09/Colgate-EVA-Invested-Capital.png" alt="Colgate EVA Invested Capital"
width="857" height="473" srcset="https://cdn.wallstreetmojo.com/wp-
content/uploads/2017/09/Colgate-EVA-Invested-Capital.png 857w,
https://www.wallstreetmojo.com/wp-content/uploads/2017/09/Colgate-EVA-Invested-Capital-
300x166.png 300w, https://www.wallstreetmojo.com/wp-content/uploads/2017/09/Colgate-EVA-
Invested-Capital-768x424.png 768w" sizes="(max-width: 857px) 100vw, 857px" />

source: Colgate SEC Filings

Invested capital represents the actual debt and equity invested in the company.

Total Debt = Notes and Loan Payable + Current Portion of Long-Term Debt + Long Term Debt

 Total Debt (2016) = $13 + $0 + $6,520 = $6,533 million

<img class="alignnone size-full wp-image-25681" src="https://cdn.wallstreetmojo.com/wp-
content/uploads/2017/09/Colgate-EVA-Net-Deferred-Taxes.png" alt="Colgate EVA Net Deferred Taxes"
width="860" height="300" srcset="https://cdn.wallstreetmojo.com/wp-
content/uploads/2017/09/Colgate-EVA-Net-Deferred-Taxes.png 860w,
https://www.wallstreetmojo.com/wp-content/uploads/2017/09/Colgate-EVA-Net-Deferred-Taxes-
300x105.png 300w, https://www.wallstreetmojo.com/wp-content/uploads/2017/09/Colgate-EVA-Net-
Deferred-Taxes-768x268.png 768w" sizes="(max-width: 860px) 100vw, 860px" />

source: Colgate SEC Filings

Adjusted Equity = Colgate Shareholders Equity + Net Deferred tax + Non Controlling Interest +
Accumulated Other comprehensive (income) loss

 Adjusted Equity (2016) = -$243 + $55 + $260 + $4,180 = $4,252 million

Colgate’s Invested Capital (2016) = Debt (2016) + Adjusted Equity (2016)

 Colgate’s Invested Capital (2016) = $6,533 million + $4,252 million = $10,785 million

#3 – Find WACC of Colgate

<img class="alignnone size-full wp-image-25683" src="https://cdn.wallstreetmojo.com/wp-

content/uploads/2017/09/Colgate-WACC-Calculation-Step-1.png" alt="Colgate WACC Calculation - Step
1" width="838" height="68" srcset="https://cdn.wallstreetmojo.com/wp-
content/uploads/2017/09/Colgate-WACC-Calculation-Step-1.png 838w,
https://www.wallstreetmojo.com/wp-content/uploads/2017/09/Colgate-WACC-Calculation-Step-1-
300x24.png 300w, https://www.wallstreetmojo.com/wp-content/uploads/2017/09/Colgate-WACC-
Calculation-Step-1-768x62.png 768w" sizes="(max-width: 838px) 100vw, 838px" />
We note from above that Colgate’s number of shares = 882.85 million

Current Market Price of Colgate = $72.48 (as of closing 15th September, 2017)

Market value of equity of Colgate = 72.48 x 882.85 = $63,989 million

<img class="alignnone size-full wp-image-25684" src="https://cdn.wallstreetmojo.com/wp-

content/uploads/2017/09/Colgate-WACC-Calculation-Step-2.png" alt="Colgate WACC Calculation - Step
2" width="857" height="202" srcset="https://cdn.wallstreetmojo.com/wp-
content/uploads/2017/09/Colgate-WACC-Calculation-Step-2.png 857w,
https://www.wallstreetmojo.com/wp-content/uploads/2017/09/Colgate-WACC-Calculation-Step-2-
300x71.png 300w, https://www.wallstreetmojo.com/wp-content/uploads/2017/09/Colgate-WACC-
Calculation-Step-2-768x181.png 768w" sizes="(max-width: 857px) 100vw, 857px" />

As we have earlier noted,

Total Debt = Notes and Loan Payable + Current Portion of Long-Term Debt + Long Term Debt

 Total Debt (2016) = $13 + $0 + $6,520 = $6,533 million

Let us now find the cost of equity of Colgate using CAPM model

 Ke = Rf + (Rm – Rf) x Beta

We note from below that the risk-free rate is 2.17%

<img class="alignnone size-full wp-image-25685" src="https://cdn.wallstreetmojo.com/wp-
content/uploads/2017/09/Colgate-WACC-Calculation-Step-3.png" alt="Colgate WACC Calculation - Step
3" width="599" height="221" srcset="https://cdn.wallstreetmojo.com/wp-
content/uploads/2017/09/Colgate-WACC-Calculation-Step-3.png 599w,
https://www.wallstreetmojo.com/wp-content/uploads/2017/09/Colgate-WACC-Calculation-Step-3-
300x111.png 300w" sizes="(max-width: 599px) 100vw, 599px" />

source – bankrate.com

For the United States, Equity Risk Premium is 6.25%.

<img class="alignnone size-full wp-image-13470" src="https://d1simgbqqcbc6q.cloudfront.net/wp-

content/uploads/2016/12/US-Risk-Premium-WACC.png" sizes="(max-width: 1157px) 100vw, 1157px"
srcset="https://d1simgbqqcbc6q.cloudfront.net/wp-content/uploads/2016/12/US-Risk-Premium-
WACC.png 1157w, https://www.wallstreetmojo.com/wp-content/uploads/2016/12/US-Risk-Premium-
WACC-300x54.png 300w, https://www.wallstreetmojo.com/wp-content/uploads/2016/12/US-Risk-
Premium-WACC-768x137.png 768w, https://www.wallstreetmojo.com/wp-
content/uploads/2016/12/US-Risk-Premium-WACC-1024x183.png 1024w,
https://www.wallstreetmojo.com/wp-content/uploads/2016/12/US-Risk-Premium-WACC-180x32.png
180w" alt="us-risk-premium-wacc" width="1157" height="207" data-lazy-loaded="true" />

source – stern.nyu.edu
Let us look at the Beta of Colgate. We note that Colgate’s Beta has increased over the years. It is
currently 0.805

<img class="alignnone size-full wp-image-25686" src="https://cdn.wallstreetmojo.com/wp-

content/uploads/2017/09/Colgate-WACC-Calculation-Step-4.png" alt="Colgate WACC Calculation - Step
4" width="643" height="362" srcset="https://cdn.wallstreetmojo.com/wp-
content/uploads/2017/09/Colgate-WACC-Calculation-Step-4.png 643w,
https://www.wallstreetmojo.com/wp-content/uploads/2017/09/Colgate-WACC-Calculation-Step-4-
300x169.png 300w" sizes="(max-width: 643px) 100vw, 643px" />

source: ycharts

Also, check out the article on CAPM Beta Calculation

 Cost of Equity = 2.17% + 6.25% x 0.805

 Cost of Equity of Colgate = 7.2%

<img class="alignnone size-full wp-image-25733" src="https://cdn.wallstreetmojo.com/wp-

content/uploads/2017/09/Colgate-WACC-Calculation-Step-6.png" alt="Colgate WACC Calculation - Step
6" width="976" height="120" srcset="https://cdn.wallstreetmojo.com/wp-
content/uploads/2017/09/Colgate-WACC-Calculation-Step-6.png 976w,
https://www.wallstreetmojo.com/wp-content/uploads/2017/09/Colgate-WACC-Calculation-Step-6-
300x37.png 300w, https://www.wallstreetmojo.com/wp-content/uploads/2017/09/Colgate-WACC-
Calculation-Step-6-768x94.png 768w" sizes="(max-width: 976px) 100vw, 976px" />

 Interest Expense (2016) = $99

 Total Debt (2016) = $13 + $0 + $6,520 = $6,533 million

 Effective Interest Rate (2016) = $99/6533 = 1.52%

Let us now calculate WACC

 Market Value of Equity = $63,989 million

 Value of Debt = $6,533 million

 Cost of Equity = 7.20%

 Cost of Debt = 1.52%

 Tax rate = 30.82%

WACC = E/V * Ke + D/V * Kd * (1 – Tax Rate)

WACC = (63,989/(63,989+6,533)) x 7.20% + (6,533 /(63,989+6,533)) x 1.52% x (1-0.3082)

WACC = 6.63%

#4 – Colgate’s Economic Value Added EVA Calculation

Economic Value Added formula= Net Operating Profit After Tax – (Capital Invested x WACC)

 Colgate’s NOPAT (2016) = $4,065 million x (1-0.3082) = $2,812 million

 Colgate’s Invested Capital (2016) = $6,533 million + $4,252 million = $10,785 million

 Economic Value Added (Colgate) = $2,812 million – $10,785 million x 6.63%

 Economic value added = $2097 million

What is the importance of Economic Value Added?

The very basic objective of every business is to maximize the shareholder value. The investor is the key
stakeholder around which all business activities are focused.

The key factors which are important while maximizing shareholder value are:

 Wealth maximization is more important as compared to profit maximization. There is a

difference between the two. Wealth maximization aims to accelerate the worth of the
organization as a whole. Maximizing profit can be said to be a subset of maximizing wealth. EVA
focuses on wealth creation.
  Economic Value Added (EVA) takes into account the Weighted Average Cost of Capital. It goes
with the logic that it is important to cover the cost of equity and not the just the interest portion
of debt.

 Organizations tend to focus on profits and ignore the cash flow. This often leads to a liquidity
crunch and can also lead to bankruptcy. Economic Value Added (EVA) focuses on cash flows
more than profits.

 By taking the Weighted Average Cost of Capital, it takes into account both short-term as well as
long-term perspectives.

Advantages and disadvantages of using Economic Value Added (EVA)

Like any other financial ratio/indicator, even Economic Value Added (EVA) has its own sets of
advantages and disadvantages. Let us have a look at the basic pointers for the same.

Advantages of using Economic Value Added (EVA):

1. As discussed above, it helps to give a clear picture about wealth creation as compared to other
financial measures used for analysis. It takes into account all costs including the opportunity cost
of equity and it does not stick to accounting profits.

2. It is comparatively simple to understand.

3. EVA can also be calculated for different divisions, projects, etc. and the appropriate investment
decisions can be taken for the same

4. It also helps to develop a relationship between the use of capital and Net Operating Profit. This
can be analyzed to make the most out of opportunities and also make appropriate
improvements, wherever necessary.

Disadvantages of using Economic Value Added (EVA):

1. There are a lot of assumptions involved in calculating the Weighted Average Cost of Capital. It is
not easy to calculate the cost of equity which is a key aspect of WACC. On account of this, there
are chances that EVA itself can be perceived to be different for the same organization and for
the same period as well. In the above Economic Value Added example, the cost of equity has
changed from the year 2015 to the year 2016. This can be one of the major factors due to a
decrease in EVA.

2. Apart from the WACC, there are other adjustments also which are required to the Net Operating
Profit After Tax. All non-cash expenses need to be adjusted for. This becomes difficult in case of
an organization with multiple business units and subsidiaries.

3. Comparative analysis is difficult with Economic Value Added (EVA) on account of the underlying
assumptions of WACC.

4. EVA is calculated on historical data and future predictions are difficult.